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Catch the Lightning in VMware's Bottle

Microsoft's scare tactics are working at the moment -- but that will change with a vengeance.

VMware(NYSE:VMW) has caught lightning in a bottle. The Rule Breaker leveraged its innovative virtual server software into a crushing lead over the budding competition. When the recession hit in 2008, VMware sat in the catbird seat, ready to pounce on the opportunity.

Yes: opportunity! A product portfolio that helps customers save money and engineering resources is a major asset when budgets get tight.

The proof is in the proverbial pudding, and this is way more creme brulee than haggis:

Q4 2008

Q4 2007

Change

Sales

$515

$412

24.9%

Net Profit

$111

$78

42.6%

EPS

$0.29

$0.19

52.6%

Free Cash Flow

$215

$118

81.3%

Source: Company release, and Capital IQ, a division of Standard and Poor's. All figures except EPS are in millions.

Tasty, eh? 25% year-over-year sales growth in a time of worldwide panic, followed up by widening margins across the board and even a reduction in diluted shares outstanding. That's a very shareholder-friendly sequence of events.

However, chief rival Microsoft(NASDAQ:MSFT) must be feeling pretty smug about the distinct lack of pop in VMware's stock. Redmond isn't happy in the runner-up position, and has been campaigning hard for its own Virtual Server product.

Mr. Softy may not have snagged too much of VMware's actual business yet. A recent IDC study shows VMware with a 78% revenue share of virtualization products, but the presence of a credible-looking competitor has made investors and analysts think twice about VMware's growth prospects. The stock is down a staggering 73% from where it was shortly before reporting Q4 earnings last year, which is much worse than Microsoft's 44% drop or the S&P 500 swooning 35%.

If anybody knows how to beat Microsoft, it's VMware CEO Paul Maritz, who spent years in the very top echelons of the Seattle software brain trust. He's also surrounding himself with former Microsoftian coworkers, including new COO Tod Nielsen. After 12 years in Redmond, Nielsen served as a senior VP at Oracle(NASDAQ:ORCL) before becoming CEO of Borland Software.

VMware holds a huge lead over every rival out there, including Microsoft, Sun Microsystems(NASDAQ:JAVA), and Citrix Systems(NASDAQ:CTXS), both in technology and in the all-important mindshare of IT professionals. None of the upstarts can match VMware's rich product portfolio, feature set, and market-leader reputation.

The company is doing everything right, and is just waiting for the stock market to understand what's going on. When -- not if -- that happens, the recoil will be tremendous.